Here’s How P/E Ratios Can Help Us Understand Northrop Grumman Corporation (NYSE:NOC)

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Northrop Grumman Corporation’s (NYSE:NOC), to help you decide if the stock is worth further research. What is Northrop Grumman’s P/E ratio? Well, based on the last twelve months it is 16.51. That is equivalent to an earnings yield of about 6.1%.

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View our latest analysis for Northrop Grumman

How Do You Calculate Northrop Grumman’s P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Northrop Grumman:

P/E of 16.51 = $311.09 ÷ $18.84 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Northrop Grumman increased earnings per share by 7.3% last year. And its annual EPS growth rate over 5 years is 16%.

Does Northrop Grumman Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Northrop Grumman has a lower P/E than the average (22.2) in the aerospace & defense industry classification.

NYSE:NOC Price Estimation Relative to Market, May 24th 2019
NYSE:NOC Price Estimation Relative to Market, May 24th 2019

This suggests that market participants think Northrop Grumman will underperform other companies in its industry. Since the market seems unimpressed with Northrop Grumman, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Northrop Grumman’s Balance Sheet

Northrop Grumman has net debt equal to 30% of its market cap. You’d want to be aware of this fact, but it doesn’t bother us.

The Verdict On Northrop Grumman’s P/E Ratio

Northrop Grumman has a P/E of 16.5. That’s around the same as the average in the US market, which is 17.4. Given it has some debt, and grew earnings a bit last year, the P/E indicates the market is expecting steady ongoing progress.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.